Ch. 7 Activity-Based Costing

Organization-sustaining activities

Includes activities such as heating the factory, cleaning executive offices, providing a computer network, arranging for loans, preparing annual reports to shareholders, and so on.

The most common reports prepared using ABC data are the product and customer ____ reports

profitability

Benchmarketing

A systematic approach to identifying the activities with the greatest potential for improvement.

To reconcile ABC product margin to net income:

Subtract overhead costs not assigned to products

Customer-level activities

activities that are carried out to support customers, but that are not related to any specific product

Unit-level activities

activities that are performed each time a unit is produced

Activities such as research and development that are not dependent on the number of units or batches are _____-level activities

Product

Duration drivers

a measure of the amount of time required to perform an activity

Transaction drivers

simple counts of the number of times an activity occurs

First-stage allocation

the process by which overhead costs are assigned to activity cost pools in an activity-based costing system

How does activity-based costing differ from traditional absorption costing?

1) Non manufacturing as well as manufacturing costs may be assigned to products, but only on a cause-and-effect basis 2) Some manufacturing costs may be excluded from product costs 3) Numerous overhead cost pools are used, each of which is allocated to products and other cost objects using its own unique measure of activity

Steps for implementation Activity-Based costing

1) define activities, activity cost pools, and activity measures 2) assign overhead costs to activity cost pools 3) calculate activity rates 4) assign overhead costs to cost objects 5) prepare management reports

Product-level activities

Activities that relate to specific products that must be carried out regardless of how many units are produced and sold or batches run.

The activity-based approach has appeal in today's business environment because it uses ____ cost pools and unique measures of activity to better understand the costs of managing and sustaining product diversity

More

Unused capacity costs

Traditional absorption costing system assign these costs to products. If the budgeted level of activity declines, the OH rate and unit product costs rise thereby ensuring that the shrinking volume of output absorbs the increasing cost of idle capacity. Activity-based costing system charges products only for the cost of the capacity they use. This provides more stable unit product costs and is consistent with the goal of assigning to profits only the costs of the resources that they use.

What causes traditional and activity-based costing systems to report different product margins?

Traditional cost systems allocate all of the manufacturing overhead costs to products using a volume-related allocation base. Traditional cost systems allocate all manufacturing overhead costs to products. The ABC system assigns nonmanufacturing overhead costs to products on a cause-and-effect basis as appropriate.

In activity based costing, products are charged only for the cost of the capacity they use, not for the cost of the capacity they don't use.

True

activity measure

An allocation base in an activity-based costing system; ideally, a measure of the amount of activity that drives the costs in an activity cost pool.

Second-stage allocation

The process by which activity rates are used to apply overhead costs to products and customers in activity-based costing.

usually, traditional costing __ high-volume products and __ low-volume products

overcosts, undercosts

What are 2 types of manufacturing overhead cost that activity based cost systems purposely do not assign to products?

Organization-sustaining costs and unused capacity costs (also called idle capacity costs)

What are the 3 essential characteristics of a successful activity-based costing implementation?

1) top managers must strongly support the ABC implementation because their leadership is instrumental in properly motivating all employees to embrace the need to change 2) top managers should ensure that ABC data is linked to how people are evaluated and rewarded 3) a cross-functional team should be created to design and implement the ABC system

activity cost pool

A "bucket" in which costs are accumulated that relate to a single activity measure in an activity-based costing system.

If ABC is not implemented correctly and organization-sustaining costs are included in product costs, then product costs will be _____ and margins will be _____

Overstated, understated

Which report or statement helps companies channel their resources into the most profitable growth opportunities?

Product and customer profitability reports

A product's _____ is a function of sales and the direct and indirect costs that that product causes

Product margin

Activity-based costing (ABC)

a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore "fixed" as well as variable costs

activity based management

a management approach that focuses on managing activities as a way of eliminating waste and reducing delays and defects

Organization-sustaining activities

activities that are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made

Activity

an event that causes the consumption of overhead resources in an organization

Batch-level activities

Activities that are performed each time a batch of goods is handled or processed, regardless of how many units are in the batch. The amount of resource consumed depends on the number of batches run rather than on the number of units in the batch.

ABC is not used for external reporting because _____ would not be comfortable using allocations based on employee interviews.

Auditors

Activity based costing uses more cost ____ than traditional costing

Pools

In an automated environment, using traditional allocation based based on volume may distort unit product costs.

True

Costs that can be easily traced to individual products include:

Commissions paid to sale persons, shipping costs, and warranty repair costs

ABC does not conform to GAAP because it:

Excludes some manufacturing costs and includes some no manufacturing costs

The most appropriate activity measure for a cost pool consisting of equipment depreciation and power to run machines is

Machine hours

Organizational sustaining cost

Manufacturing overhead costs that include costs such as the factory security guard's wages, the plant controller's salary, and the cost of supplies used by the plant manager's secretary. Tradition absorption costing systems assign these types of manufacturing costs to products even though they are totally unaffected by which products are made during the period. Activity-based costing systems treat these types of costs as period expenses rather than arbitrarily assigning them to products.

Most organizations that use activity-based costing has what 2 costing systems?

The official costing system that is used for preparing external financial reports and the activity-based costing system that is used for internal decision making and for managing activities

In the 19th and 20th centuries, direct labor hours was a satisfactory overhead allocation base

True

When making decisions using ABC data:

Unavoidable fixed costs should be ignored

Cost driver

Used when referring to an allocation base or activity measure in activity-based costing